East EU manufacturing fall bodes ill for third quarter

PRAGUE | By Michael Winfrey

PRAGUE Europe's festering debt crisis and weak domestic demand pushed Czech and Polish manufacturing into contraction for the fifth month running in August, boding ill for the emerging eastern EU's chances of pulling out of a slide by the end of the year.

The European Union's two biggest eastern economies posted worse-than-forecast growth data for April to June, with the Czechs falling into a third quarter of recession and the Polish economy slowing sharply despite an expected boost from the Euro 2012 soccer tournament.

With the euro zone crisis crimping demand for their exports and government austerity forcing businesses and consumers to cut costs at home, a growing stream of data indicates the situation in both countries will worsen at least until next year.

Purchasing Managers' Index (PMI) figures - which reflect business activity and are often an accurate predictive indicator for future growth - showed a sharpening slowdown in Poland, the only EU state that did not suffer from contraction since 2008.

Despite second-quarter growth that was relatively strong compared to other EU states, its PMI was pulled down by weak new orders and output, falling to a 38-month low of 48.3 in August, below analysts' forecasts and a sharp fall from 49.7 in July.

The Czech PMI fell to 48.7 from 49.5 in July, remaining below the 50 point boundary that demarcates expansion from contraction.

"The Czech PMI is in line with growth. It's still signalling that it's not going to recover in the third quarter," said Daniel Hewitt, an economist at Barclay's Capital.

"In addition, with Poland, their growth... disappointed but was still well within positive territory. But the PMI is in line with growth possibly easing more in the second half of the year, which everyone fears."

Parallel data from the euro zone, which central Europe usually tracks with a lag of a month or two, showed more reason for gloom. Factory activity there tumbled faster than expected, with the headline euro zone PMI figure registering 45.1.

Hungarian PMI data, compiled under different methodology, fell to 49.5 in August, from a revised 51.8 in July.

POLICY EASING ON HORIZON

The data pushed the region's currencies lower, with the Polish zloty, Czech crown and Hungarian forint slipping 0.3 to 0.7 percent weaker against the euro.

Analysts said the data could lead monetary policy officials in the Czech and Polish central banks to ease policy in the coming months from their key policy rates of 0.5 and 4.75 percent.

The Czech economy shrank 0.2 percent in the second quarter compared with January to March. The central bank expects the economy to shrink 0.9 percent this year, but has also said it could revise that downward.

With Prime Minister Petr Necas's government having hiked taxes and cut investment and other spending, the domestic economy there is shrinking, illustrated by a 1.1 percent fall in real wages in the second quarter, data showed on Monday.

Poland, the region's biggest economy, grew by 2.4 percent in the second quarter, much better than most of its faltering EU peers but worse than expected despite its co-hosting of the Euro 2012 soccer tournament.

The June contest also marked the end of a 20 billion euro ($25 billion) infrastructure investment spree that doubled the amount spent by London on its Olympic Park over a five year period and has been a major driver of growth there.

Its tapering off has hit construction, which plunged 8.8 percent in July on a yearly basis, and plunged a wave of builders into bankruptcy including the largest listed contractor PBG PBGG.WA.

Investors are now awaiting a plan by Prime Minister Donald Tusk's plan to revive growth, expected this month.

Central bank governor Marek Belka has indicated the bank's Monetary Policy Council may start cutting interest rates much sooner than previously expected, with forward rate agreements pricing in the first 25 basis point cut in October.

"The (PMI) data is another strong argument for the dovish faction at the Polish MPC. We expect the MPC to cut rates in October," said Piotr Bujak, chief economist at Nordea Bank Polska.

(Additional reporting by Marcin Goettig in Warsaw and Jana Mlcochova in Prague; Editing by Hugh Lawson)